COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 18.10.2000COM(2000) 658 final

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THEEUROPEAN PARLIAMENT

PROGRESS REPORT ON THE RISK CAPITAL ACTION PLAN

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EXECUTIVE SUMMARY

This Communication reviews progress in implementing the strategy for developing the EUrisk capital market in light of the conclusions from the Special Lisbon European Council andthe deadline of 2003 set for full implementation of the Risk Capital Action Plan (RCAP).

The EU risk capital market performed very well in 1999 but remains small and fragmented incomparison to that of the United States. Although there is no evidence of a generalised marketfailure, early stage and technology investment remains particularly low. Further developmentof the EU risk capital market requires accelerated market integration, the easing of country-specific constraints on efficient market functioning and, more generally, the promotion of amore entrepreneurial culture.

Timely implementation of the Financial Services Action Plan (FSAP) will do much to foster amore integrated EU risk capital market. A wide range of measures included in the FSAP andrelevant to risk capital have been recently adopted by the Commission or are underpreparation by the Commission services. In addition, the Community patent proposed by theCommission will do much to lower costs and increase legal certainty for innovativeenterprises wishing to operate outside their own Member State. It is crucial that all relevantparties co-operate to ensure early agreement on the introduction of these measures intoCommunity law.

Structural reform to promote risk capital at the national level is proceeding. In severalMember States, regulatory constraints on institutional investment in equity markets have beenrelaxed and the administrative procedures for establishing a business have been lightened.However, little has been done to address the disincentive effects of bankruptcy and insolvencyprocedures in most of the Member States. Modest progress is being made in addressing fiscalobstacles to risk capital investment, with adjustments having been made to the taxation ofcorporate profits and capital gains in some of the Member States. However, tax reforms willneed to be accelerated and extended if the RCAP is to be implemented by the deadline.

A series of Community actions to promote a culture of entrepreneurship have been taken.Entrepreneurship is one of the four pillars of the Employment Guidelines. The Guidelines for2001 proposed by the Commission call for greater entrepreneurship awareness across thesociety, while the European Social Fund finances a series of educational and trainingprograms in this area. The Commission has also taken actions to promote innovationthroughout the Union, for instance, by highlighting the practices employed in the moresuccessful regions. Member States also are taking measures in this area, notably promotingentrepreneurship through funding of relevant disciplines in private and public universities,promoting technology transfers to SMEs, and fostering co-operation between SMEs,academics and large enterprises.

The philosophy underlying the strategy for developing the EU risk capital market attributesprimary importance to an environment that is favourable to creating and sustaining a new andinnovative business. Consistent with this philosophy, there is a limited role for public fundingas a means to address identifiable market failures. However, as with all cases for publicfunding, the advantages need to be weighed against risks of market distortion and, particularlyin the risk capital area, of displacing or crowding out private sector activity.

Much remains to be done if the EU risk capital market is to be brought onto par with that ofthe United States. To this end, it is essential to implement the RCAP by the deadline of 2003.

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1. INTRODUCTION

Although small in relation to other financial markets, the risk capitalmarket1 is of unique importance in providing a source of equityfinancing for young and innovative businesses. As indicated in the April1998 Risk Capital Communication2, several studies suggest a highemployment content in the activities of innovative SMEs, although theemployment effects cannot be quantified exactly. Various surveys havealso highlighted the role venture capital funding and IPOs can play inthe development of high growth companies. In this way, a developedand efficient risk capital market has a significant role to play instimulating sustainable economic growth and employment creation.

Importance of riskcapital investment tosustainableeconomic growthand employmentcreation wasacknowledged bythe special LisbonCouncil conclusions.

Objective of thisCommunication is toreview the strategyto develop the EUrisk capital market inlight of the Lisbonconclusions.

The promotion of entrepreneurship and innovation lies at the heart ofthe strategy for the creation of a knowledge-based EU economy as setout in the conclusions of the special Lisbon European Council(March 2000). Accordingly, the Council identified the development of apan-European market for risk capital as a high priority. The Councilalso called for the implementation of the Risk Capital Action Plan(RCAP), as annexed to the April 1998 Risk Capital Communication, by2003. The RCAP proposes initiatives to be taken at Community and/orat Member State level in the areas of market fragmentation, institutionaland regulatory barriers, taxation, paucity of high-tech SMEs, humanresources and cultural barriers. The Commission has presented a firstdetailed report (October 1999) on the implementation of the RCAP3.The next implementation report will be based on the monitoring andbenchmarking mechanism described in Annex 14. This Communicationhas the more limited objective of reviewing the strategy for developingthe EU risk capital market so as to take account of the Lisbonconclusions. In particular, it is proposed to establish the priority areasfor action to ensure implementation of the RCAP by the 2003 deadline.

The Communication is structured as follows. Section 2 provides acontext for the strategy review by briefly summarising the maindevelopments in the EU risk capital market in 1999. In Section 3,progress in implementing the strategy is examined along three mainaxes, i.e. measures to foster market integration, structural reformmeasures and measures to promote a culture of entrepreneurship. Therole of public funding is also briefly considered. Section 4 presents

1 The risk capital market comprises informal investment by “business angels”, more formal venturecapital investment and investment in specialised markets for new and potentially high-growthcompanies.

2 "Risk Capital: A Key to Job Creation in the European Union”, SEC(1998)552.3 “Risk Capital: Implementation of the Action Plan: Proposals for moving forward”; COM(1999)493 and

its annex, the working document of the services SEC(1999)17254 The Member State authorities have already been consulted on the monitoring and benchmarking

mechanism.

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some general conclusions.

All segments of theEU risk capitalmarket performedwell in 1999.

2. MAIN DEVELOPMENTS IN EU RISK CAPITAL MARKET IN 1999

2.1.A clearly improving trend

The EU risk capital market performed strongly in 1999 and nowaccounts for about 5% of the total capital raised on all EU stockmarkets. This favourable performance has extended to all segments ofthe risk capital market, i.e. investment by business angels, venturecapital investment and the high-growth equity market. Business angelsare individual investors who invest in small and medium-sized business.Data limitations make it difficult to monitor the activity of businessangels on a systematic basis, but there is evidence to suggest that thenumber of active business angels in Europe is increasing. In 1998 and1999, the number of business angels networks in the EU has almostdoubled to a total of 110 active networks. However, 80% of thenetworks are located in only 3 Member States.

EU venture capitalinvestment grew by70% relative to1998.

Data on formal venture capital investment are more readily availableand indicate an increase of 70% to about€12 billion (0.14% of GDP) in1999 from about€ 7 billion (0.09% of GDP) in 19985. This verysubstantial increase is reflected in the number of investments made (upby 56%), as well as in the number of companies financed (up by 44%,some 7300 companies). Although the EU private equity market hastraditionally focused on more profitable later-stage investments such asmanagement buy-outs (MBOs), it is notable that early-stage investmentdoubled to about€ 3 billion in 1999 relative to 1998 and was ten timeshigher than in 1995.6 An analysis of the expected allocation of fundsraised in 1999 confirms this trend, with about€ 5.5 billion (22% of totalfunds raised) earmarked for future early-stage investments.

5 These statistics do not include Luxembourg, for which data are not available.6 Investment in early stage, a key stage in the development of a company, is high-risk and has tended to

yield lower returns than MBOs. However, the performance of early-stage investments has improved asthe EU venture capital market has matured and the gap relative to returns from MBOs has narrowed.

5

0

2,000

4,000

6,000

8,000

10,000

12,000

1995 1996 1997 1998 1999

Graph 1: Venture capital investment in the EU

expansion

early stage

€m

Source: EVCA

EU stock markets foryoung andinnovativecompanies werebuoyant in 1999.

In reviewing developments in EU risk capital, the performance of thespecialised stock markets for high-growth companies must also beconsidered. These markets, which are closely linked to venture capitalactivity because they provide an important “exit route” for investors,experienced significant growth world-wide in 1999. Their developmenthas been influential in the progress of a more financial andentrepreneurial culture in the EU. The EU markets for young and highgrowth companies have performed particularly strongly, continuing abuoyant trend since their creation in the late 1990s. In view of the sharpincrease in share prices the preceding months, the decline after March2000 can largely be seen as a market correction and a step towardsgrowing maturity in this type of investment.7 As significant as risingshare prices has been the sharp increase in the number of companieslisted on these markets. The Neuer Markt recently listed its 300thcompany, while about 140 companies are listed on Le Nouveau Marchéand about 430 are listed on AIM. Several new specialised markets werecreated in 1999 and 2000, e.g. the Nuovo Mercato in Italy and theNuevo Mercado in Spain. A total of€10 billion was raised on all EUspecialised markets (some 80% of this on the Neuer Markt) during thefull-year 1999, and a further€13 billion has already been raised in thefirst six months of 2000.

7 These markets are likely to be characterised by considerable price volatility due to the high-risk natureof the assets involved, their small size and the limited free float weight on their liquidity.

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Table : Main markets specialising in SME financing as at 30 June 2000

Euro. NM

LeNouveauMarché(Paris)

NeuerMarkt NMAX

Euro.NMBelgium

NuovoMercato

EASDAQ AIMtech-

MARK 1 NASDAQ

Launch Mar 96 Mar 97 Mar 97 Mar 97 June 99 Nov 96 June 95 Nov 99 Feb 71

467Number of companieslisted (A) 140 281 15 16 15

62 429 220 4 843

240Market capitalisation(billion €) (B) 27 191 1.7 0.5 20

50 22.6 1 006 5 818

13.4Capital raised(current year, billion €) 1.2 9.5 0.4 0 2.3

0.3 1.6 3.1 33.2

513Average capitalisation percompany (million €)(B)/(A) 192 678 116 31 1 340

806 53 4 574 1 201

537Capital exchanged(million €/day)2

37 442 5 0.2 5332 48 3 633 76 680

+17%Performance of indexsince 30 December 1999 +26% +17% + 4% +14% +2%

-8% -11% -8% -3%

Sources :Euro.NM, EASDAQ, LSE, NASDAQ, own calculations.

1 Since launch on 4 November 1999.2 Average, current month.

Development of EUrisk capital marketmust be viewed inwider context ofglobalisation andtechnologicalprogress.

2.2.Several forces shaping market developments

The progress achieved in developing the EU risk capital market must beviewed in the context of profound changes in the functioning of the EUfinancial system as a whole. These changes are, in large part, a responseto the wider influence of globalisation. The application of new andadvanced technologies to the international financial system hasintroduced a new dimension of competition by removing geographicalbarriers and by transforming traditional market structures (e.g. theemergence of automated trading systems). Financial markets andintermediaries have responded to these changes by developing globalmarket strategies which involve achieving greater size through mergersand acquisitions and operating on a world-wide basis. Risk capitalmarkets, although less globalised than other financial markets, have alsoexperienced significant change. Notably, the typical structure ofinvestment projects funded through the financial markets has changed,with an increased tendency for so-called “new economy” enterprises toseek direct financing through the specialised equity markets. Theseenterprises often need a large capital infusion over a number of yearsbefore becoming profitable but their high earnings potential hasattracted investors. The most obvious manifestation of this phenomenonhas been in the information technology sector, where there has been asurge in the number of stock-market listings fuelled by high investordemand for IT companies' shares.

EU risk capitalmarket alsoinfluenced byspecific factors such

Within the European Union, the transformation in financial markets –including risk capital markets – has been intensified by reinforcedefforts to complete the single market for financial services and by the

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as financial-marketintegration and theintroduction of theeuro.

introduction of the euro. The combined effect of these more EU-specificfactors will be to accelerate the emergence of deep, broad and liquidfinancial markets. More indirectly, the fiscal discipline implied by EMUis releasing additional capital for private-sector investment by reducingpublic borrowing requirements and stimulating a “crowding in” effect.Privatisation of publicly owned enterprises – often linked to budgetaryconsolidation strategies - has increased the offering of equities. In manyMember States including Germany, France and the United Kingdom,the number of households holding shares has increased sharply in recentyears, fuelled by generally buoyant stock prices as well as by thecontinued withdrawal of the public sector from commercial activities. Inthis general environment, risk capital activity has also expanded asinvestors seek out a higher yield on their investments and reduce therelative share of banks deposits in their portfolio.

EU continues tounderperform the USin terms of venturecapital investment,particularly in thetechnology sectors.

2.3.Still room for improvement

Despite the progress made in 1999, the EU risk capital market remainssmall in comparison to that of the United States, particularly in respectof early-stage investment and investment in technology sectors. USventure capital investment rose to€ 33 billion in 1999, an increase of150% relative to 1998. Of this total,€ 13 billion (42%) was in early-stage investment – more than total EU venture capital investment andmore than four times EU investment in early-stage companies. TheEuropean early-stage venture capital market remains small and lackingin transparency, with a limited correlation between risk and return. Thisunfavourable comparison puts the recent expansion of the EU riskcapital market in perspective and highlights the extent of the challengesstill to be overcome. On the other hand, it should be noted that theexpansion in US venture capital investment in 1999 was largely due toan increase in the size of individual "deals" rather than to an increase inthe number of investments. The relatively large size of deals in the USmarket can be partly attributed to a higher percentage of technologyinvestment, especially in Internet-based services. In 1999, investmentsin technology sectors (mainly software industry, telecommunicationsand Internet-based services) amounted to€18 billion in the UnitedStates but to little more than€ 5 billion in Europe8. However, somecommentators have interpreted the increasing size of US deals asevidence of a speculative bubble and have questioned the quality ofsome recent venture capital investments.

8 The European and US data are not directly comparable as the European survey includes unsecured debt,whereas the US survey does not include debt and as the US survey includes technology-relatedinvestments in other non-technology categories (such as the new media category and IT consulting inthe business services category).

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Graph 2: Comparison between venture capital investments inEurope and the US in 1999

6,690

504

204

334

921

1,098

15,355

977

1,023

840

6,899

3,395

4,899

2,107

n.a.

n.a.

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000

Other sectors

Biotechnology

Medical Instr./Devices

Electronics related

Computer related

Netw orking & Equipment

Internet Technology

Communications Europe US

€m

Source: PwC, Money for Growth, Technology Investments Report 1999

Divergence inMember Stateperformance reflectsfragmentation of EUventure capitalmarket.

The EU risk capital market compares unfavourably with the US marketalso in that it is highly fragmented with little cross-border activity. Thisfragmentation is reflected in marked differences in performancebetween the Member States. In 1999, the level of venture capitalinvestment ranged from 0.32% of GDP in the Netherlands to 0.04% ofGDP in Austria. Three groups of Member States can be distinguished:(i) the Netherlands, Belgium, United Kingdom, and Sweden withventure capital investment representing more than 0.2% of GDP andbroadly comparable to the US situation a year before; (ii) Finland,Germany, France, Spain and Ireland with a ratio between 0.1% and0.2% of GDP; and (iii) Greece, Italy, Denmark, Portugal and Austria,where the venture capital market remains smaller than 0.1% of GDP. Asimilar pattern is observed in respect of early-stage investments with thenotable exception of the United Kingdom, where early-stage investmentrepresents less than 0.02% of GDP despite the existence of a relativelylarge venture capital market. The Member States also differ in relationto investment in the technology sector, with more than 50% of venturecapital investment devoted to technology in Belgium, France, Irelandand Sweden but very little technology investment in the less developedmarkets of Austria, Greece and Portugal.

9

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

A P DK I EL IRL E F D FIN S UK B NL EU US

Graph 3: Venture capital investments in EU MemberStates and the US in 1999

(% of GDP)

Early stage ExpansionSource: EVCA, PwC

Fragmentation alsoa feature of thesespecialised stockmarkets within theEuropean Union.

As with the venture capital market, the EU stock market for young andhigh-growth companies is fragmented, with marked differences inperformance from Member State to Member State. Cross-bordercomparison is made difficult by the specific characteristics of thenational markets. The extent of the differences is illustrated by thecontrast between the Neuer Markt and AIM. The Neuer Markt has anaverage market capitalisation of€ 680 million, 40 foreign listings9 and70% of all listings are in the technology sector, while AIM has anaverage market capitalisation of only€53 million with listingspredominantly UK-based and only 15% in the technology sector. As EUfinancial integration proceeds, we can expect the creation of a pan-European stock market for high-growth companies. The merger of theBrussels, Amsterdam and Paris exchanges to create Euronext, representsa step in that direction.

Despite progress in1999, strategy todevelop EU riskcapital market mustbe implementedurgently.

3. THE STRATEGY FOR DEVELOPMENT OF THE EU RISK CAPITAL

MARKET

The favourable performance of the EU risk capital market in 1999 is acause for optimism. Nevertheless, the EU market continues to under-perform that of the United States by a considerable margin. While thereis no evidence of a generalised market failure in the European Union,the divergence in performance between Member States points to

9 25% being Austrian, as no such market exists in Austria.

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problems of market fragmentation and to the existence of country-specific constraints on more efficient market functioning. Moregenerally, the underperformance of the EU risk capital market wouldseem attributable also to an inadequate entrepreneurial culture in manyof the Member States. All of these factors indicate the need to proceedwith the full implementation of the RCAP by the 2003 deadline at thelatest.

In this section, the strategy to develop the EU risk capital market isrevisited along three main axes. These are: (i) measures to foster marketintegration; (ii) structural reforms to address country-specific marketconstraints; and (iii) measures to promote a culture of entrepreneurshipwithin the Member States. Attention is focused both on progress to dateand on measures outstanding under the RCAP, while distinguishingbetween those measures under Community responsibility and thoseunder the responsibility of the Member States. The role of publicfunding in developing the EU risk capital market is also brieflyconsidered.

Marketfragmentationmeans investmentdecisions are stillmainly country-driven.

3.1.Measures to foster market integration

The removal of exchange risk between euro-area countries has madecurrent matching requirements between assets and liabilities obsoleteand suggests that portfolio allocation decisions should be increasingly“sector-driven” rather than “country-driven”. The economic policyconvergence implied by EMU is further expected to diminish country-specific factors influencing investment decisions. However, evidencefrom company valuation to date does not indicate a major shift towardsector-specific valuation. A likely explanation for this is the continuedfragmentation of EU financial markets. Accordingly, measures to fosteran appropriate degree of market integration are a central element of theLisbon strategy for stimulating more efficient financial markets ingeneral and more efficient risk capital markets in particular.

Timelyimplementation ofFinancial ServicesAction Plan toensure EU financialmarket integration.

The Lisbon European Council provided an important impulse to theintegration of EU financial markets and EU risk capital markets inparticular. Paragraph 20 of the Presidency conclusions states that“it isessential … to push forward the integration of EU financial markets”and recognises that“efficient risk capital markets play a major role ininnovative high-growth SMEs and the creation of new and sustainablejobs”. Paragraph 21 is more specific and requires that steps should betaken to complete the implementation of the Financial Services ActionPlan (FSAP) before 2005 and of the RCAP before 2003. Furthermore,the paragraph underlines the importance of some FSAP priority actionareas, including two that are highly relevant for the RCAP: (i)facilitating the widest possible access to investment capital on EU-widebasis, including for SMEs by means of a “single passport” for issuers,and (ii) facilitating the successful participation of all investors in anintegrated market by eliminating barriers to investment in pensionfunds.

FSAP on course for Implementation of the FSAP (into which all measures of financial

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implementation by2005.

regulatory nature in the RCAP have been integrated) is proceeding at areasonable pace. Two progress reports have already been presented tothe Council (November 1999 and May 2000)10. A third progress reportwill be presented to the Council of 27 November 2000. Following arequest from the Council of 17 July 2000, it will include two newelements: (i) a priority-related "critical path" to achieve the objectives ofthe FSAP by 2005, and (ii) possible indicators (benchmarks) to measureprogress towards realising the economic benefits of an integrated EUfinancial services sector. The FSAP priority-related critical path willtake into account the Lisbon deadline for the implementation of theRCAP (2003). Of particular importance for the development of the EUrisk capital market will be the timely adoption of the Directive on theprudential supervision of supplementary pension funds, the twoDirectives on UCITS, the amendments of the prospectuses Directivesand the legislative follow-up to the EU accounting strategyCommunication.

Committee of WiseMen to focus onpracticalarrangements forapplying EU rules.

The Council of 17 July 2000 took another important decision whichshould facilitate the integration of EU financial markets. This was to setup a “Committee of Wise Men”11, chaired by Mr. AlexandreLamfalussy. As a follow-up to the FSAP, this Committee will focus onthe practical arrangements for implementing Community rules and willpropose scenarios for adapting current practices in order to ensuregreater convergence and co-operation between regulators.

Progress on the relevant actions included in both the FSAP and theRCAP includes:

A range of measureshave been recentlyadopted by theCommission or areunder preparation bythe services in areassuch as commonprospectuses,corporate governance,accounting andauditing procedures,prudential rules forinstitutional investorsand reform of thepatent system.

• Upgrading of directives on prospectuses to facilitate companiesraising cross-border capital (e.g. IPOs)

The Commission is preparing a proposal in close co-operation with theMember States and, in particular, with FESCO (Forum of EuropeanSecurities Commissions).The ad-hoc working group of FESCO, wherethe Commission is an observer, completed its work in mid-2000. Theobjective of the working group is not only to provide for improved(simpler, cheaper, faster) cross-border procedures but also to facilitatethe introduction of modern features such as “shelf registration”12. TheCommission intends to table a proposal on this subject before end-2000.In addition, there is a broad consensus that access to cross-border capitalby SMEs would be facilitated by agreement at EU level on whichinvestors should qualify as professionals. In this regard, a

10 See htpp://europa.eu.int/comm/internal_market (financial services, action plan section)11 See htpp://europa.eu.int/comm/internal_market (financial services, general matters section)12 ie prospectus prepared in a two-step procedure: a “reduced” prospectus containing everything except for

the information concerning the specific securities involved in the issue, which isfiled once a year withthe competent home authority. Then, when the time is right for an issue, the companies prepare the“issue note” describing the characteristic of the offer and of the securities. Belgium, Spain, France, theUK and Italy already make use of the shelf-registration procedure.

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Communication on the distinction between “sophisticated” and “retail”investors is expected to be adopted by the Commission before end-2000as part of the FSAP.

• Dissemination of best practices in corporate governance

The Commission has launched13 a review of existing codes of corporategovernance with a view to identifying any legal or administrativebarriers which could frustrate the development of a single market infinancial services. The results of this review should be available in thesecond half of 2001.

• Assessment of existing accounting and auditing requirements

On 14 June 2000, the Commission adopted a Communication onfinancial reporting strategy. A central feature of the new policy is theintroduction of a requirement for all EU-listed companies to preparetheir consolidated financial statements in accordance with InternationalAccounting Standards (IAS). This requirement would enter into force atthe latest from 2005 onwards. Appropriate legislation will be proposedby the Commission before end-2000. Concerning statutory audit, theCommission will issue before end-2000 a Recommendation on externalquality assurance, based on the work of the EU Committee on Auditing.

• Adoption of prudential rules to allow institutional investors to investin venture capital

Substantial progress has been made in the year 2000 with regard toinvestment funds (UCITS). Following the adoption of amendedproposals by the Commission (30 May 2000), the Council is expected toreach political agreement on the first proposal in October 2000. Politicalagreement on the second proposal is expected to be reached beforeMarch 2001. This should pave the way for an early adoption of the twonew directives. With regard to pension funds, the Commission hasadopted (11 October 2000) a proposal for a directive on the prudentialsupervision of supplementary pension funds14. This proposal takes intoaccount the diversity of pension funds operating in the European Unionand covers authorisation, reporting, fit and properness, and rules onliabilities and solvency. Investment rules will be based on the “prudent-man” principle and ensure that pension funds can invest in risk capitalmarkets.

• Reform of the European Patent System15

On 5 July 2000, the Commission adopted a proposal for a Regulationfor a Community patent to give inventors the option of obtaining a

13 call for tender published on 21 March 200014 COM(2000)507prov15 This measure is not part of the FSAP but is highly relevant to risk capital markets.

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single patent legally valid throughout the European Union. Under theCommission proposal, Community patents to be issued by the EuropeanPatent Office would be both affordable and legally certain. In particular,it is expected that a Community patent would reduce translation costs tosome €2,200 by not requiring any translation beyond that alreadyforeseen in the Munich Convention for the granting of the patent.Concerning legal certainty, the Commission suggests that a newcentralised Community tribunal within the framework of the EuropeanCourt of Justice should be set up to deal with disputes related to thequestion of infringement and validity of Community patents. Thiswould require an amendment of the Treaty.

Structural reforms tobe focused onregulatory and fiscalconstraints at thenational level.

3.2.Structural reforms to address country-specific constraints

Efforts to foster a more integrated EU risk capital market need to besupported by appropriate and timely structural reforms to addresscountry-specific constraints on the efficient functioning of risk capitalmarkets. These reforms are mainly the responsibility of Member Statesand will, of course, vary with national circumstances. However, twomain categories of structural reforms - regulatory and fiscal - to developrisk capital markets in the Member States were emphasised in thecontext of the RCAP.

Limits on institutionalinvestment in equitymarkets reduce riskcapital supply.

3.2.1. Easing regulatory constraints

Regulatory constraints on the development of risk capital markets are oftwo types. The first type relates to legal provisions limiting the scope forinstitutional investment in risk capital and tend to impact negatively onthe supply side of the market. Only four of the Member States (i.e.Finland, Ireland, the Netherlands and the United Kingdom) have nolegal restrictions - beyond a general requirement for prudence - oninvestment in equities by banks, insurance companies and pensionfunds. Constraints on institutional investment may not be the onlybarrier to institutional investment in risk capital16, but the USexperience following the decision to relax the “Prudent ManRegulation” (1978) suggests that the removal of quantitative constraintscould provide a major boost to the development of risk capital in theEU.

The proposed EU Directive on occupational retirement provision (seeabove) addresses this type of barrier in respect of supplementarypension funds, which are among the more important institutionalinvestors. The Directive stresses that national investment rules mustensure that pension funds, inter alia, can invest in risk capital markets inaccordance with the “prudent-man” principle. Meanwhile, many of theMember States have already taken actions to allow specific institutional

16 as highlighted by the review of institutional investment launched by the UK Treasury (May 2000) toinvestigate the factors distorting institutional investor’s decision making.

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investors to invest in unquoted companies. In Sweden, a new regulatoryframework for pension provision allows insurance companies andpension funds to increase their investment allocation to private equityand these institutional investors are now the main suppliers of venturecapital. In France, the introduction of the so-called “DSK” life-insurance contract (1998) provides tax incentives for insurers to invest50% of their portfolio in equity, including a minimum investment of 5%in unlisted securities, while the regulation applying to the main Frenchventure capital vehicle, the “Fonds Communs de Placement à Risques”has been improved, allowing for the creation of funds of funds and of“light” 17 funds for professional investors. In Italy, some limitations oninvestment rules for closed-end funds have been removed (1998) anddomestic mutual funds in Spain have been authorised (1997) to investup to 10% of their assets in unlisted securities. Denmark is alsoconsidering the possibility of raising the proportion of private pensionsavings which can be invested in non-quoted stocks. Despite thesemeasures, removal of quantitative constraints on investment in equitycapital – including risk capital – needs to be given higher priority.

Reducedadministrativeburden should boostdemand for riskcapital but still littleimprovement inbankruptcy andinsolvencyprocedures.

The second type of regulatory barriers to the development of risk capitalmarkets includes administrative procedures for setting up a company,procedures following bankruptcy and insolvency, etc. These barrierstend to impact on the demand side of the market by increasing the costof business creation. In most of the Member States, significant progresshas been made in simplifying administrative procedures, through thecreation of one-stop shops for example. The period necessary to registera company has been generally reduced. For example, a company cannow be established in 24 hours in France (although a period of 2 to 3days is more likely), in 5 days in Ireland, in 12 days in Denmark, and 3weeks in Portugal (3 months previously). In contrast, there has beenlittle progress in improving the application of laws on bankruptcy andinsolvency so as to ensure that the consequences of business failure arenot so severe as to discourage desirable risk taking.18 Indeed, many ofthe cultural barriers (see section 3.3) that have been identified as majorimpediments to entrepreneurship and risk taking within EU MemberStates continue to be reinforced by the current legal environment. Thenecessity to reform procedures following bankruptcy and insolvency hasbeen long recognised and should now become a clear priority for theMember States.

Capital gains taxmatters forinvestment,particularly in higher-risk activity.

3.2.2. Easing fiscal constraints

The structure of taxation can act as barrier to the development of riskcapital in several ways.

First, the tax structure can have a negative impact on investment if the

17 Applying a simplified procedure.18 The UK government has begun consultation on these matters.

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after-tax rate of return to the investor is deemed too low. In this context,the most relevant feature of the tax structure for the development of riskcapital markets is the rate of capital gains tax. It is notable that US riskcapital investment accelerated in the early 1980s following a reductionin capital gains tax (1978), but decelerated after the 1986 Tax ReformAct in which capital gains tax was increased. Against this background itappears worthwhile examining whether reductions of capital gains taxescould play an equally positive role in promoting the development of EUcapital markets. Clearly, the issue of capital gains taxation is related tomany other aspects of tax law (e.g. inheritance tax) and of the overalltax structure (e.g. relative weight of labour taxation), so that thisassessment needs to take account of the broader implications of capitalgains taxes within a given tax system. The taxation of stock options isalso an area that can be looked into, inter alia, from this perspective.

Tax structure oftendisadvantagesequity financingrelative to debtfinancing,constraining riskcapital activity.

Second, the tax structure may hinder investment in equity by grantingrelatively favourable treatment to debt financing. A study of the EUeffective tax burden by Baker & McKenzie (1998)19 concluded that debtfinancing is a more tax-efficient means to develop a company than theuse of retained earnings or new equity capital. With the exceptions ofFinland and Italy, all of the Member States favour the use of debt overequity financing in their tax structures although it must be recalled thatother factors such as availability and cost of financing will play anequally important role in a company’s financing decision. The Finnishtax system affords equal treatment to new equity and debt and FinnishSMEs would seem to have a high and increasing ratio of own fundsrelative to SMEs in other Member States. The Italian tax system hasactually favoured equity financing since 1998 but Italian SMEs remainrelatively indebted. The future evolution in the financial structure ofFinnish and Italian SMEs should act as a test case in assessing thepotential to develop risk capital via a more balanced tax treatment ofdebt and equity financing. The Commission services are examiningthese questions indepth in the context of an ongoing comprehensivestudy on company taxation in the EU. The results of this study will beavailable early in 2001.

Tax structure mayput barriers to cross-border investment

Third, the tax structure may hinder cross-border investment by creatingspecific tax obstacles or even discriminating against foreign investors. Acomprehensive response to such barriers might be achieved mosteffectively through co-ordinated action on EU-level. In any event,Member States have to make sure that tax treaties and/or other tax lawinstruments prevent double taxation of dividends in cross-borderinvestments. The above-mentioned Commission company tax study willamong other things look into these questions in some depth.

Member States haveembarked on tax

Tax reform was identified as a key priority in the context of the RCAP

19 « Survey of the effective tax burden in the European Union », Baker & McKenzie, January 1999, studycommissioned by the Dutch Ministry of Finance.

16

reforms but moreneeds to be done toreduce disincentiveeffects onentrepreneurship.

and reform efforts are already underway in many of the Member States.Germany is to reduce its corporate and income tax rates and to eliminatecorporate tax on the sale of shares of other companies held in theportfolio by corporation from 2002.20 France is also to reduce itscorporate and income tax and has increased tax benefits granted toreinvesting business angels. Italy is to grant favourable tax treatment toclosed-end investment funds and Spain has granted tax incentives toregistered venture capital investors. Several of the Member States havealso made progress in reducing the tax disincentives to businesscreation. It is also important that Member States design their taxsystems so to ensure that the taxation of share ownership and stockoptions do not act as a disincentive to entrepreneurship21. In the UnitedKingdom and Ireland – where the tax environment is already largelysupportive of risk capital investment - taxation of share options has beenreformed.22 In France, the application requirements for the system of"Bons de Souscription des Parts et Créateurs d’Entreprises (BSPCE)"have been expanded and extended to the end of the year 2001 althoughthe reform of stock option plans has still to be completed.

Both theCommission and theMember States havebeen active inpromoting a cultureof innovation andentrepreneurship.

3.3.Promoting a culture of entrepreneurship

Europe still faces a backlog in innovation and innovative companies. Inits recent communication “Towards a European research area23”, theCommission stressed the importance of encouraging and facilitating thecreation of new firms by researchers. Both the Commission and theMember States have been strengthening their action to promotetechnology transfer to SMEs and foster the creation of firms as well ascooperation between SMEs, academics and large enterprises.

The Communication on Innovation in a Knowledge-Driven Economy24

adopted by the Commission on 20 September presents the currentsituation of high-tech enterprises and proposes a strategy for innovationin the future. The Trend Chart on Innovation Policy is providinginstruments to follow up and design innovation policy initiatives. Threereports25 to be released in the autumn will contain indicators on humanresources, knowledge creation, transmission and application ofknowledge, innovation, output and markets. The reports will alsoexamine some 60 measures implemented by the Member States last yearto support venture capital, seed capital, incubators, etc. In the

20 if these shares have been held for at least a year.21 The Commission staff working paper annexed to the October 1999 Risk Capital Communication

(SEC(1999)1725) highlighted the benefits of employee ownership schemes such as stock options, andgave some examples of good practices.

22 i.e. deferral of the tax liabilities until the shares are sold in Ireland, along with a “Save As You Earn”scheme; “All Employee Share Ownership Plan”, and “Enterprise Management Incentive” schemes inthe UK.

23 COM(2000)624 COM(2000)56725 (i) the "European Innovation Scoreboard for the Knowledge Economy"; (ii) the monitoring report on

"Start-up and technology based companies", and (iii) the monitoring report on "Innovation Finance".

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framework of Community research programs, various actions have beenundertaken and will be pursued to foster the creation of technology-based firms and interfacing between researchers, entrepreneurs andinvestors. For instance, the “Biotechnology & Finance Forum”, set upjointly by the Commission Life Science programme and the EuropeanAssociation of Security Dealers (EASD), organised two conferences(1998 and 1999) to promote networking between relevant actors in thearea of biotechnology. A third conference will take place in November2000.

Under the PAXIS action, 15 innovative economic areas in Europe havebeen selected to establish a network promoting best practices. InNovember 2000, the second forum for innovative enterprise will takeplace in Lyon, allowing entrepreneurs to give feedback on policies(regional, national or EU-wide) that are to be put in place to helpEurope achieve a knowledge and innovation-based society.

As venture capital funds still face difficulties in recruiting skilledinvestment managers (capable of analysing innovative businesses basedon recent R&D findings), the Commission has launched an action underthe I-TEC initiative to extend the exchange of experience and goodpractice between venture capital operators, technology incubators, andindustrial liaison offices linked to research institutes and universitiesacross Europe. In addition, through its support to new business angelsnetworks at European, national, and regional level, the Commissionfacilitates the matching of informal investors and start-up businesses.

The Commission is to publish this autumn the first BESTImplementation report bringing together all aspects of policy affectingentrepreneurship and competitiveness at European and Member Statelevel. Entrepreneurship is one of the four pillars of the EmploymentGuidelines and the Commission’s proposed Guidelines for 2001 call forgreater entrepreneurial awareness across society and in educationalcurricula. The European Social Fund finances a series of educationaland training programs in this area, while some Member States havetaken direct measures to overcome cultural barriers to entrepreneurshipby introducing the teaching of entrepreneurship in schools and funding(publicly or with the private sector) chairs for entrepreneurship atprivate and public universities. In addition, award schemes forentrepreneurs now operate in a number of Member States.

A role for publicfunding limited toaddressingidentifiable marketfailures.

3.4.The role of public funding

The philosophy underlying the strategy for developing the EU riskcapital market attributes primary importance to the creation of anenvironment favourable to creating and sustaining new and innovativebusinesses. The measures contained in the RCAP to facilitate marketintegration, to ease market constraints and to promote a culture ofentrepreneurship are in keeping with this philosophy. Consistent withthis approach, there is a role for public funding limited to addressingidentifiable market failures. However, as with all cases for publicfunding, the advantages need to be weighed against risks of market

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distortion and, particularly in the risk capital area, of displacing orcrowding out private sector activity. In the state aid rules, theCommunity has a mechanism and a procedure to follow which allowsthis balance to be struck. Member States are obliged to ensure that allmeasures are consistent with the state aid rules. This may meannotification to the Commission under Article 88(3) of the Treaty so thatthe Commission can assess the measure’s compatibility with thecommon market.

A range of financing instruments are available at EU level, managed bythe EIB, the EIF and the Commission. It will be recalled that the Lisbonconclusions mandate the Commission to review the coherence of EIBand EIF financing of risk capital activity. This matter is dealt with in aseparate Communication.26

4. CONCLUSION

There is increasing evidence to suggest that the long-term performanceof an economy is positively related to the level of development of itsfinancial system. More specifically, a growing number of studies pointto a relationship between economic growth and the ready availability ofinnovation financing27. Thus, access to risk capital can play a key rolein sustaining economic growth and employment creation by allowingfor the development of new and innovative businesses.

Despite the favourable developments in 1999, the European risk capitalmarket is still lagging behind the US market. In response, action hasbeen taken at EU and Member State level to improve the structural andregulatory environment conditioning the development of risk capital andentrepreneurial firms. The Commission has tabled or is preparingseveral legislative measures to improve the efficiency of the EUfinancial market. Timely adoption of the FSAP, especially, will domuch to foster a more integrated EU risk capital market. In drafting theBroad Economic Policy Guidelines, it has stressed the importance ofstructural reforms. Member States have also responded with a series ofstructural reforms and actions to promote entrepreneurship. However,more needs to be done if the RCAP is to be implemented by thedeadline of 2003 set by the special Lisbon European Council.

Implementation of the RCAP requires action on many fronts, butpriority should be given to three areas - all of which fall under MemberState responsibility. These are (i) the easing of quantitative constraintson institutional investment in equity capital (to be replaced by “prudent

26 See reference.27 For example, see “How do financial systems affect economic performance ?”, W. Carlin and C. Mayer ,

July 1999.

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man “ legislation28); (ii) the softening of bankruptcy laws to allow failedentrepreneurs a second chance (while affording adequate protection ofcreditors’ rights); and (iii) the development of a fiscal framework moreconducive to investment and entrepreneurship. Substantial progress inthese priority areas, combined with accelerated progress of financialintegration will do much to ensure the economic and legal environmentnecessary for a thriving EU risk capital market.

28 A principle to be introduced into Community legislation for supplementary pension funds (cf. theCommission proposal of 11 October on supplementary pension funds).

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ANNEX 1

BENCHMARKING AND MONITORING OF THE RISK CAPITAL ACTION PLAN

A. BACKGROUND

An efficient market for risk capital plays an important role in the development of innovative,high-growth SMEs and, in this way, contributes significantly to sustainable economic growthand employment creation. Having identified a need to foster the further development of riskcapital in the EU, the Commission adopted a Communication and an Action Plan (April 1998)to this end. A first analysis of the implementation of the Risk Capital Action Plan (RCAP)was carried out in October 1999 and revealed that, while some progress had been made, theEU still suffered weaknesses in the availability of risk capital. Further to this analysis, theECOFIN requested that the Commission should prepare a monitoring and benchmarking29

mechanism for the RCAP. This mechanism is expected to facilitate implementation of theRCAP before the deadline of 2003 agreed by the Lisbon European Council.

The RCAP proposed a wide range of measures to foster the development of an efficient riskcapital market within the EU. These measures, to be taken by the Commission and by theMember States, relate to six different areas i.e. market fragmentation, institutional andregulatory barriers, taxation, paucity of high-tech SMEs, human resources and culturalbarriers. Several of the measures contained in the RCAP are also elements of current EUpolicies to stimulate innovation, to improve the single market in financial services and topromote entrepreneurship and competitiveness. There is, therefore, a substantial overlapbetween the actions proposed under the RCAP and those included in the Commission’s actionplans on innovation, financial services and entrepreneurship. Accordingly, it is intended thatthe monitoring and benchmarking mechanism for the RCAP should draw upon correspondingmechanisms already in place to follow the implementation of the “Action Plan to Implementthe Framework for Financial Markets30” (FSAP), the “Action Plan to PromoteEntrepreneurship and Competitiveness31” (BEST) and the “Innovation Action Plan32” . Inaddition, the mechanism for the RCAP will be closely co-ordinated with the benchmarkingexercise - also requested by the Lisbon European Council - to create a friendly environmentfor starting up and developing innovative business, especially SMEs. Finally, the mechanismshould benefit from the work underway in preparing a broader analysis of structural indicatorsin connection with the BEPG and the Synthesis Report. By exploiting the information

29 Benchmarking is a continuous, systematic process for comparing the performance of organisations,enterprises, economies etc. against a chosen standard. It is a learning process aimed at identifying andimplementing best practice. The main steps of a benchmarking process are:- Identification of a target to be improved;- Development of a specific performance indicator(s), i.e. benchmark(s), for comparison;- Comparison of own performance against the benchmark;- Analysis of best practice and potential for improvement;- Implementation of best practice;- Continuous monitoring.

30 COM(99)23231 COM(98)55032 COM(96)589

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available from these and other sources, it should be possible to limit the number of newindicators required specifically for monitoring the RCAP.

Some of the actions included in the RCAP have now been taken and can be assessed directly.Other actions have a longer-term perspective and their impact on the risk capital market maynot be measurable directly. Moreover, any monitoring mechanism for the RCAP must takeaccount of the fact that these markets are evolving rapidly. At this stage, it is proposed thatthe monitoring and benchmarking mechanism of the RCAP should include:

(1) a set of indicators of developments in risk capital markets

(2) for each of the actions contained in the RCAP,

– a summary of progress to date,

– whenever relevant, an analysis of best practices,

– whenever possible, the development of specific performance indicators

The mechanism should be designed to allow for regular updating of the RCAP byidentification of those actions that are no longer relevant and possibly the inclusion of newactions.

B. DEVELOPMENT AND MONITORING OF INDICATORS OF THE RISK CAPITAL MARKET .

Risk capital is the generic term for a set of equity financing instruments for companies in theirearly stages of growth. It covers three types of financing: informal investment by businessangels, venture capital, and raising of capital on stock markets specialised in high growthcompanies (the so-called “new markets”). The monitoring of risk capital markets will bebased on monitoring of these three main forms of equity financing. It will also refer toindicators of financial structure, as equity financing is to be analysed in relation to other formsof external financing for a company. Special attention will be given to SMEs’ financing.Comparison will be made with the US market.

In May 1997, at the request of the Industry Council, a pilot initiative on benchmarking offramework conditions for European industry was launched jointly by the Commission and theMember States. One of the four projects under this initiative concerned benchmarking thefinancing of innovation and was co-ordinated by the Danish Ministry of Business andIndustry. The RCAP made use of the output from this project and included several of itsrecommendations. It seems appropriate, therefore that the monitoring mechanism for theRCAP should use, whenever relevant and possible, the indicators proposed in that project.

Proposed indicators of development of the risk capital markets

Indicator Data availability

SMEs financial structure- own funds ratio- ratio of financial indebtedness

BACH database. Problem: time lag and coverage(the data bank currently covers 11 Member states,the US and Japan). For some countries (mainly,Germany and Austria), the sample is limited only toincorporated businesses.

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Indicator Data availability

Investment by business angels No comprehensive data presently available.Somefragmented information available from the EuropeanBusiness Angels Network (EBAN)

Access to venture capital:

Ratios of VC investments to GDP;breakdown by:- investment stage- industry/sector

Number of companies having received seedand start-up financing; to be compared withnumber of companies created within the year

EVCA, yearly; from 2000, will be available twice ayear. (PwC for US data).

The ratio of number of companies having receivedseed and start-up financing to the number ofcompanies created within the year will not becomparable between Member States as data onbusiness birth rates are not yet harmonised.

Access to stock markets for high-growthcompanies:- Capitalisation (relative to GDP)- Number of companies quoted (relative to

population)- Share turnover (value of share trading)- Number of IPOs (relative to population)- Capital raised (relative to GDP)

FIBV, yearly;

C. MONITORING OF THE MEASURES PUT FORWARD IN THE RISK CAPITAL ACTION

PLAN

C.1. Market fragmentation

The structure of risk capital markets is evolving rapidly. Before monitoring the impact of themeasures put forward in the RCAP to reduce market fragmentation, it is necessary to analysethe impact of broader developments e.g.: Euronext, ECNs, etc. More specifically in relation torisk capital, a set of indicators on market integration should also be used:

Indicator Data availability

Proportion of cross-border VC investments EVCA

Proportion of cross-border IPOs on high-growth stock markets

FIBV

Proportion of VCC exits by IPO

Number of venture-backed IPOs

EVCA

Stock markets

C.1.1. Measures under the Commission’s responsibility

• Market monitoring and development of information and statistics on all levels of venturecapital in the EU

The main source of information on venture capital in the EU is EVCA’s yearly private equitysurvey. In the framework of the implementation of the BEST Action Plan, the Commissionhas received some complementary information from the Member States. The “trend chart on

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innovation” (established in the framework of the Action Plan for Innovation) will also, amongother things, gather information on the history and results of national and EU policy measuresto support venture capital. Additional sources of information are the study “corporateventuring in Europe” commissioned by the Commission in 1999 to gauge the resurgence incorporate venture capital activity in Europe and the study on the typical growth paths taken bybiotechnology and information technology firms and the role that different types of financiersplay in this regard.

• Round table on the impact of the fragmentation of the European risk capital market

This action has been completed. The round table was organised at the end of November 1998.It contributed to a better understanding of the role played by risk capital markets in fosteringeconomic growth and job creation. It also highlighted the importance of breaking downcultural barriers to entrepreneurship in Europe and the need for a more integrated EU riskcapital market. (Report published in Euro Papers, n° 32, January 1999).

• Detailed examination of the cost to European firms of raising debt and equity finance

A study of this issue has been launched by the Commission and will be completed by end2000. Based on this study, it may be possible to define some indicators of the cost of debt andequity financing. An indicator of the cost of capital would be very useful, but no suchindicator is presently available in the EU.

C.1.2. Measures under the responsibility of the Commission and Member States

• Develop networks of business angels at regional, national and Community levels

Business angel networks have been created in most of the Member States, sometimes withpublic support. The European Commission supports the development of such networksthrough its support to EBAN (the European Business Angels Network) as well as through thefinancing of feasibility studies and specific projects.

Indicator Data availability

Number of active business angel networks The European Business Angels Network (EBAN)database (only limited coverage). The data areavailable from 1998.

• Public financial support to develop venture capital, innovation finance and improve accessto stock exchanges33

The Risk Capital Communication from the Commission (April 1998) focused on improvingthe framework for risk capital financing through the removal of barriers to market access. Itdid not include any specific recommendation concerning financial support by the State.However, several of the reports sent by Member States (early in 1999) on the implementationof the RCAP included reference to public financial instruments aimed at developing venturecapital and innovation finance. Several Member States also made reference to theseinstruments in their Cardiff reports on product and capital markets. The subsequent RiskCapital Communication (October 1999) highlighted the role of State support as a catalyst to

33 Measure not specifically included in the April 1998 Risk Capital Communication

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the provision of risk capital. While structural reform of the market and the efficient use ofpublic funding can be complementary, it is important that government intervention should notdistort the functioning of capital markets and should respect the rules on state aids.

The Commission services are currently preparing a review of the Community financialinstruments in support of venture capital. Reference will be made to the results of this reviewin the context of monitoring the RCAP.

C.2. Institutional and regulatory barriers

C.2.1. Measures under the Commission’s responsibility

These are mainly legislative actions that cannot be monitored readily by means of indicators.However, once adopted, the transposition and implementation of legislation by the MemberStates can be monitored via a scoreboard.

• Venture-capital funds: Assessment of whether there is a need for Community legislationcovering specific closed-end funds

The Commission convened the UCITS Contact Committee at the end of 1998 to considerwhether it would be appropriate to extend Community legislation on investment funds tocover venture capital funds. Representatives from the venture capital industry, the stockexchanges specialised in fast-growing SMEs, and the SMEs’ associations participated in themeeting. The consensus was that such a directive is not desirable.

• Review of implementation and possible amendment of prospectus directive to facilitatecompanies raising cross-border capital (e.g. IPOs)

A draft proposal for a directive is under preparation, in close co-operation with FESCO.Member States are consulted through various committees, The adoption of the directive isexpected to take place before end-2000. The objective is not only to improve cross-borderprocedures but also to introduce modern features such as “shelf registration”34Cross-borderactivity of SMEs would also benefit greatly from a common agreement at EU level on whichinvestors should qualify as professionals. The Commission is co-operating with FESCO onthis subject. The ad-hoc working group of FESCO completed its work in May 2000. As partof the FSAP, the Commission will issue a Communication on the distinction between“sophisticated” investors and retail investors before end-2000.

• Assess existing accounting and auditing requirements

In order to accelerate the completion of a single and competitive securities market, the LisbonEuropean Council requested urgent action in the field of financial reporting in particular toenhance comparability of financial statements. In June 2000, the Commission adopted a

34 Shelf-registration is a prospectus prepared in a two-step procedure. First, companies prepare, at thesame time as they prepare their annual reports, a “reduced” prospectus (the RD – Reference document)containing everything except for the information concerning the specific securities involved in theissue. This is filed once a year with the home competent authorities. Then, when the time is right for anissue, the companies prepare the SN (securities or issue note) describing the characteristic of the offerand of the securities. Investors, instead of the classical prospectus receive the RD, the SN and all theinformation concerning recent relevant news. Belgium, Spain, France, the UK and Italy already makeuse of self-registration procedures.

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communication on financial reporting in Europe. A legislative proposal should be adopted bythe Commission before the end of 2000.

A central feature of the new policy is the introduction of a requirement for all EU listedcompanies to prepare their consolidated financial statements in accordance with InternationalAccounting Standards (IAS). This requirement will enter into force from 2005 onwards. TheIAS to be applied by listed companies will be identified by an endorsement mechanism to beset up at EU level. The new policy also puts strong emphasis on the need for properenforcement of the standards. Main actions in this area will concentrate on disseminatingimplementation guidance, encouraging high audit quality and reinforcing co-ordinatedregulatory oversight. Member States may extend the application of IAS to unlisted companiesand to individual accounts.

In order to ensure that the Accounting Directives can remain the basis for financial reportingfor all limited liability companies, the Commission will introduce a proposal for themodernisation of the Accounting Directives before the end of 2001.

In order to make it possible for EU companies to apply IAS without coming into conflict withthe Accounting Directives, the Commission introduced (24 February 2000) a proposal toamend the Accounting Directives so as to allow the application of fair value accounting forcertain financial assets and liabilities.

Concerning statutory audit, the Commission will issue Recommendations on external qualityassurance later this year, on the basis of the work of the EU Committee on Auditing. FurtherRecommendations on auditor independence and auditing standards will follow at a later date.These Recommendations constitute the implementation of actions announced in the 1998Communication on “statutory audit within the EU” and aim to ensure a harmonised highquality statutory audit practice in the EU.

C.2.2. Measures under the responsibility of Member States

• Transposition and implementation of all financial services directives - monitoring viasingle market scoreboard

Progress in removing institutional and regulatory barriers to the integration of risk capitalmarkets can be assessed on the basis of the Commission’s single market scoreboard. Thesituation as of May 2000 is reproduced below:

26

Banks Insurance Securities Paymentsystems

Companylaw

Total Position

B 22/22 22/22 14/14 2/2 15/15 75/75 1

DK 22/22 22/22 14/14 2/2 15/15 75/75 1

D 22/22 22/22 14/14 2/2 14/15 74/75 12

EL 22/22 22/22 14/14 2/2 15/15 75/75 1

E 22/22 22/22 14/14 2/2 15/15 75/75 1

F 22/22 22/22 14/14 1/2 15/15 74/75 12

IRL 22/22 22/22 14/14 2/2 15/15 75/75 1

I 22/22 22/22 14/14 0/2 15/15 73/75 14

L 22/22 22/22 13/14 1/2 15/15 73/75 14

NL 22/22 22/22 14/14 2/2 15/15 75/75 1

A 22/22 22/22 14/14 2/2 15/15 75/75 1

P 22/22 22/22 14/14 2/2 15/15 75/75 1

FIN 22/22 22/22 14/14 2/2 15/15 75/75 1

S 22/22 22/22 14/14 2/2 15/15 75/75 1

UK 22/22 22/22 14/14 2/2 15/15 75/75 1

EU 100% 100% 99.52% 86.66% 99.56% 99.46% /

State of play including the infringement procedures for non-conformity:

Banks Insurance Securities Paymentsystems

Companylaw

Total Position

B 22/22 20/22 14/14 2/2 15/15 73/75 11

DK 22/22 22/22 14/14 2/2 15/15 75/75 1

D 22/22 21/22 14/14 2/2 14/15 73/75 11

EL 22/22 22/22 14/14 2/2 15/15 75/75 1

E 22/22 22/22 14/14 2/2 15/15 75/75 1

F 22/22 20/22 14/14 1/2 15/15 72/75 14

IRL 22/22 22/22 14/14 2/2 15/15 75/75 1

I 22/22 22/22 14/14 0/2 15/15 73/75 11

L 22/22 21/22 13/14 1/2 15/15 72/75 14

NL 22/22 22/22 14/14 2/2 15/15 75/75 1

A 21/22 22/22 14/14 2/2 15/15 74/75 9

P 22/22 22/22 14/14 2/2 15/15 75/75 1

FIN 22/22 21/22 14/14 2/2 15/15 74/75 9

S 22/22 22/22 14/14 2/2 15/15 75/75 1

UK 22/22 22/22 14/14 2/2 15/15 75/75 1

EU 99.69% 97.87% 99.52% 86.66% 99.56% 98.75% /

• Simplification of administrative formalities for company formations (including minimumcapital requirements)

Several Member States have undertaken reforms in this area, but major progress is stillnecessary as stressed by the Lisbon European Council. Indicators to follow-up on this

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progress would be particularly useful. However no comprehensive and up-to-date data ispresently available. The Commission continues to work on this issue.

Indicator Data availability

Delays and cost for company registration No data presently available. The only dataavailable on are from the Logotech studycommissioned in 1997 by the EuropeanCommission. Data refer to the situation in 1996 andare totally outdated. In the framework of theimplementation of the BEST Action Plan, MS havebeen asked to provide more recent data to theCommission. The Lisbon European Councilspecifically asked the Commission and the Councilto benchmark this issue.

Capital requirements for setting up firms No data presently available. The onlycomprehensive data available are from the Logotechstudy commissioned in 1997 by the EuropeanCommission. Data refer to the situation in 1996. Thisindicator is not included in the follow-up to theBEST Action Plan. No updated data is expectedfrom MS.

• Reform of the legislation on insolvency and bankruptcy

In the absence of comprehensive data, it is difficult to set up a monitoring mechanism underthis heading. However, the Commission services will highlight examples of good practices onthe basis of the information to be provided yearly by the Member States in their nationalreports on products and capital market reforms.

C.2.3. Measures of Commission’s and Member States’ responsibility

• Adoption of prudential rules to allow institutional investors to invest in venture capital

In July 1998, the Commission adopted two proposals modifying the UCITS Directive. Oneproposal would remove barriers to cross-border marketing of units of collective investmentfunds by widening the scope of assets in which those funds can invest. The other proposalwould provide the European passport to management companies and would widen the rangeof activities that they are allowed to undertake (e.g. they may also be authorised to provideportfolio management services). Technical discussions on these proposals are progressing inthe Council, while the European Parliament completed its first reading on 17 February 2000.

Regarding pension funds, the Commission has proposed on 11 October 2000, a directive onthe co-ordination of laws, regulations and administrative provisions relating to institutions foroccupational retirement provision. Investment rules will be based on the “prudent-man”principle and ensure that pension funds can invest in risk capital markets.

Many Member States have taken or plan to take action to remove quantitative restrictions thatimpede pension funds from using the most efficient and sound investment policies. Theimportance of this issue has been stressed in the 2000 BEPG. Member States should report onprogress made in this area in their national reports on products and capital markets reforms.

Comparison will be made with institutional investment in the US.

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Indicator Data availability

Institutional investment as a proportion ofGDP

Institutional investment in equity as aproportion of GDP

EUROSTAT / OECD.

Ratio of funds raised by VCFs from pensionfunds and insurance companies to total fundsraised

EVCA; whenever possible, a distinction will bemade between domestic and non-domesticinstitutional investors.

Prudential investment rules for institutionalinvestors

Data to be updated. The pilot 1998 study“Benchmarking financing of innovation” contained atable listing the main prudential rules and constraintsfor institutional investors. It will need to be regularlyupdated through the information to be collected inthe yearly national reports on products and capitalmarkets reforms.

C.3. Taxation

• Taxation of venture capital funds ( issue of transparency to avoid double taxation)

• Capital gains tax

• Stock options

• Tax arrangements for new firms

• Taxation of low-risk capital (e.g. bank deposits, bonds) compared with venture capital

Actions in the fiscal and taxation area are to be taken at national level; however, theCommission can play a role in analysing the situation and highlighting examples of bestpractice. The fiscal issues are key to the development of risk capital in the EU, but it shouldbe noted that any preferential tax schemes may give rise to state aid issues.

The monitoring of the fiscal framework is difficult, as tax regulations are complex and subjectto regular change. No comprehensive indicator could be defined for this section. However,reference could be made to the implicit tax rate on other factors of production: (taxes on self-employed persons + taxes on capital)/net operating surplus of the economy (i.e. capital andentrepreneurial income).

To benchmark fiscal issues, use will be made of existing studies such as

– Taxation of corporate profits, dividends and capital gains, EVCA, 2/99;

– Breaking the barriers, report on multinational share schemes, European Centre forEmployee ownership, 4/99 (includes analysis of the taxation);

– Effective tax burden in the EU, study commissioned by the Dutch Minister of Finance,1/99).

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The review of Member State’s national reports on product and capital market reforms shouldalso provide examples of best practices

The work underway in the Commission services on company taxation will also be helpful.Two panels of experts have been set up to review the issues of company taxation in Europeand fiscal barriers to the Single Market. They are expected to report in autumn 2000.

C.4. Paucity of high-tech small businesses

C.4.1. Measures under the Commission’s responsibility

• Creation of a pan-European club for high-tech innovative firms

Progress under this heading will be monitored on the basis of growth in the EuropeanFederation of High Tech Enterprises created in 1999.

• Reform of the European patent system

The Commission has proposed on 5 July 2000 a Regulation, to introduce a patent that wouldbe unitary and valid throughout the EU. The court jurisdiction with regard to this EU-widepatent will be centralised both in the first and second instance. Developments in this areacould be monitored by using an indicator on world share of European and US patents.

C.4.2. Measures under the responsibility of the Commission and Member States

• Development of networking and clustering between universities, research centres, financialbackers, lawyers, human resources specialists etc., and link them at European level

Several actions have been undertaken by Member States and by the Commission in this area.Based on information already transmitted or to be transmitted to the Commission by MemberStates in the framework of the BEST and Cardiff exercises, examples of best practices will behighlighted.

No indicator is proposed yet to monitor these actions. In the future, use could be made ofsome of the indicators proposed by the Commission in the framework of the benchmarking ofnational research policies, especially the indicator proposed on the monitoring the number ofspin-offs generated by universities and research centres.

• Development of customised electronic commerce modules for small businesses to easetheir access to electronic commerce and the internal market.

It will be impossible to monitor progress under the very specific heading of development ofcustomised electronic commerce modules for SMEs. Member States' reports in 1999 showvarious initiatives in favour of e-commerce but nothing as specific as the development ofcustomised e-commerce modules. The Commission is to publish a report on electroniccommerce and SMEs. Reference could be made to the number of SMEs using the Internet forcommercial purposes (data is available for 1998, further surveys are to be launched in thefuture)

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C.5. Human resources

• Promotion of entrepreneurship and innovation within educational and training systems

No indicator can be used in this regard. The Commission will report on progress in projectsthat it has launched in this area, such as the project (launched in June 1999) on thedevelopment of European entrepreneurship training modules, in collaboration withuniversities, business schools, as well as investors and financiers, and the project to set up aBusiness Education Network of Europe (BENE) which will bring together trainingorganisations with proven experience in training for entrepreneurship to exchangeexperiences, identify best practice and adjust the courses and curricula to changing demand. Itwill also highlight examples of fruitful actions undertaken by the Member States in this area.The Member States' National Action Plans on employment include a presentation of progressmade in this area. Although the NAPs do not provide standardised data across all MemberStates, they may offer input for actions/practices to be further developed.

• Determination of training needs for venture-capital fund managers, market makers,analysts of high-tech firms

No indicator can be used. The Commission will report on the results of the study it launchedto determine training needs for venture-capital fund managers, market makers, and analysts ofhigh-tech firms, as well as on some other initiatives undertaken in this area.

• Assessment of benefits of equity pay and employee ownership schemes

The Commission staff working paper (SEC (1999) 1725) on the implementation of the RCAPincluded an analysis of the economic and financial impact of employee stock ownership andstock option schemes, as well as the necessary conditions for development of these schemesin the EU. The importance of employee ownership and stock option schemes has beenstressed in the BEPG 2000. The Commission will report on the result of a study that it hascommissioned on “a company perspective on financial participation in the EU; objectives andobstacles”. In addition, Member States should report on developments in this area within theframework of the yearly national reports on product and capital market reforms.

C.6. Cultural barriers

• Demonstration of the advantages of venture capital and promotion of entrepreneurship

This issue is linked with the above-mentioned actions on promotion of entrepreneurship.

• Dissemination of best practices in corporate governance

Corporate governance has been identified by the Commission as one of the issues to beexamined in the context of creating deep and liquid European capital markets. A series ofcorporate governance codes have been adopted over the past decade with the aim of betterprotecting the interests of shareholders and/or stakeholders. A number of projects in this areaare still in the preparation phase. Differences in corporate governance arrangements maycreate unnecessary uncertainty and complexity for both cross-border issuers and cross-borderinvestors who might not benefit from the same rights everywhere. Based on theseobservations, the Commission decided to launch a review of existing codes of corporategovernance with a view to identifying any legal or administrative barriers that could frustratethe development of a single market in financial services. The results of this review Areexpected to be available in the second half of 2001.

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D. CONCLUSION

The Member States authorities, consulted on this mechanism, have expressed their support tothe proposed scheme, as well as to the chosen indicators. They have also given some usefuldata for some indicator for which comprehensive data is presently not available. Likewise,representatives of the industry have welcomed the monitoring and benchmarking of the RiskCapital Action Plan. As the mechanism is set, data will be collected, and will be presentedand analysed in the next Risk Capital Action Plan Implementation Report.

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ANNEX 2

ACRONYMS USED IN THE RCAP

AIM : Alternative Investment Market [London]

EIB : European Investment Bank

EIF : European Investment Fund

EASDAQ : European Association of Securities Dealer Automated Quotation[Brussels]

EURO. NM : Nouveau Marché (Paris) + Neuer Markt (Frankfort) + NouveauMarché (Brussels) + Nieuwe Markt (Amsterdam) + Nuovo Mercato(Milan)

EVCA : European Venture Capital Association

FESCO : Forum of European Securities Commissions

FIBV: Federation Européenne des Bourses de Valeurs InternationalFederation of Stock Exchanges

IAS : International Accounting Standards

ICT: Information Communication Technology

ISD : Investment Services Directive (93/22/EEC)

IT : Information Technology

NASDAQ : National Association of Securities Dealers Automated Quotationsystem

RTD : Research and Technological Development

SOEC : Statistical Office of the European Communities

SME : Small and Medium sized Enterprises

UCITS : Undertakings for Collective Investment in Transferable Securities;(Investment funds)

US GAAP : US Generally Accepted Accounting Principles

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Annex 3

GLOSSARY OF TERMS USED IN THE RCAP

Accounting Directive: Directives 78/660/EEC and 83/349/EEC.

Business Angels: Private individuals who invest directly in new and growingunquoted businesses. Business angels usually provide finance inreturn for an equity stake in the business, but may also provideother long-term finance. This capital can complement the venturecapital* industry by providing smaller amounts of finance(generally under EUR 150 000) at an earlier stage than mostventure capital firms are able to invest.

Capital market: A market in which long term capital is raised by industry andcommerce, the government and local authorities. Stock exchangesare part of the capital market.

Corporate governance: The manner in which organisations, particularly limitedcompanies, are managed and the nature of accountability of themanagers to the owners. This topic has been of increasedimportance since the beginning of the 1990’s, the providers ofexternal finance to a company wanting to ensure management isnot acting contrary to their interests.

Corporate venturing: Provision of venture capital by a company for another company.

Development capital: Financing provided for the growth and expansion of a company.

Early stage capital: Financing to companies before they initiate commercialmanufacturing and sales, before they be generating a profit.Includes seed* and start-up* financing.

Electronic commerce: Direct marketing of trading using a computer or a TV screen.

Equity: The ordinary share capital of a company.

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High level SecuritiesSupervisors Committee:

Informal advisory group created in 1985 by the Commission andthe EU Securities Supervisory Regulators with the purpose ofdealing with co-operation and cross border matters. It will bereplaced by the Securities Committee

Institutional investors: This term refers mainly to insurance companies, pension fundsand investmentfunds collecting savings and supplying funds to themarkets, but also to other types of institutional wealth (e.g.endowment funds, foundations, etc).

IPO: Initial Public Offering (flotation, going public) : the process oflaunching a public company for the first time by inviting thepublic to subscribe in its shares.

Investment ServicesDirective:

Directive 93/22/EEC. It provides a European “passport” forinvestment firms (brokers, dealers, etc.) and gives the right toelectronic exchanges to place their terminals in other MemberStates.

Management buy-out: Financing provided to enable current operating management andinvestors to acquire an existing product line or business.

Market capitalization: The price of a stock multiplied by the total number of sharesoutstanding. The market’s total valuation of a public company. Byextension, the total valuation of companies listed on a stockmarket.

Primary market: Market into which a new issue of securities is launched.

Private equity: As opposed to public equity; investment in equity stake by privateinvestors in companies not listed on a stock market.

Prospectus: A formal written offer to sell securities that sets forth the plan fora proposed business enterprise, or the facts concerning an existingone that an investor needs to make an informed decision.

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Prospectus Directive: Documents drawn up according to the rules of Directives89/298/EEC (public offers) and/or 80/390/EEC (listingparticulars).

Prudent-man regulation: Obligation of pension managers to invest as a prudent investorwould do on his own behalf, in particular by carrying out sensibleportfolio diversification, with no limits to portfolio distributionother than on self investment for pension funds financing definedbenefit plans. NL, UK, Ireland USA, Canada, Australia have sucha legislation.

Regulated markets: Organized markets where buyers and sellers meet to tradeaccording to agreed rules and procedures. Markets meeting theconditions set under article 1.13 of the ISD.*

Replacement capital: Purchase of existing shares in a company from another venturecapital investment organization or from another shareholder orshareholders.

Risk capital markets: Markets providing equity financing to a company during its earlygrowth stages (start-up* and development*). In the framework ofthis communication, it covers three sorts of financing:

- Informal investment by Business Angels*

- Venture capital.∗

- Stock markets specialized in SMEs and high growthcompanies.

Secondary market: Market where securities are bought and sold subsequent tooriginal issuance. The existence of a flourishing, liquid, secondarymarket creates the conditions for a healthy primary market.

∗ Word defined in the glossary or the acronyms.

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Securities Committee : To be created. It will have both consultative and comitology rolesand will replace the High Level Securities SupervisorsCommittee. In the securities area it will have the same role as theBanking Committee in banking and the Insurance Committee ininsurance.

Security: A financial asset, including shares, government stocks,debentures, bonds, unit trusts and right to money lent or deposited.

Seed capital: Financing provided to research, assess and develop an initialconcept.

Start-up capital: Provided to companies for product development and initialmarketing.

Stock exchange

(Stock Market):

A market in which securities are bought and sold. Its basicfunction is to enable public companies, governments and localauthorities to raise capital by selling securities to investors.

Stock option: Option given to employees and/or managers to buy shares at afixed price.

Venture capital: Investment in unquoted companies by venture capital firms who,acting as principals, manage individual, institutional or in-housemoney. Four main financing stages are identified in relation to thestages of development of a venture-backed company : earlystage,* expansion*, replacement* and buy-out.* In the USA, theword “venture capital” does not include most of the buy-out deals.

Venture capital funds Closed-end funds, created to provide venture capital.

∗ Word defined in the glossary or the acronyms.